Q1 2022 Conformis Inc Earnings Call

Okay.

Good morning, and walk you through the first quarter 2022 earnings conference call for conformance.

My name is Michelle and I'll be your conference operator today.

All lines have been placed on mute to prevent any background noise. After management's remarks, there'll be a question and answer session.

I would like to remind you that this call will include forward looking statements within the meanings that the federal Securities Law, which are made pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act of 1995 any statements made during this call. They are not statements of historical facts should be considered forward looking these statements involve material.

Risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward looking statements, including those discussed in the risk factors section of conformance public filings with the U S Securities and Exchange Commission you.

You should not place undue reliance on these forward looking statements conformance disclaims any obligation except as required by law to update or revise any financial projections or forward looking statements, whether because of new information future events or otherwise. This conference call will include time sensitive information and is accurate.

As a black broadcast today may 4th 2022, I will now turn the call over to Mark Augusta, President and Chief Executive Officer of performance.

Thank you and welcome everyone to our first quarter earnings call with me today is our CFO , Bob Hau Weird.

We had a quarter of steady progress with our Disney and Britney system, our new Platinum services program and the products in our development pipeline.

These are cornerstones of our product and service offerings going forward and we believe will be the catalyst for our growth.

We achieved several milestones during the quarter. We successfully completed our 250 is incorrect procedure and now have over 500 orders in the queue.

Clinical feedback remains compelling and we continue to see a positive response from the ASC market, which is the primary target for this product.

Importantly input is already on contract at nearly 70% of our existing accounts and average prices roughly the same as I total identity.

This positions us well to drive gross margins as orders and procedures ramp.

We remain on pace to transition to the full market release in June at which time, we anticipate that we will have incurred on contract with well over 90% of our customers to support the full launch with a series of training and medical education events plan to drive further awareness and expand surgeon access the.

The market has reacted very favorably to this new.

Knee offering.

We expect this to continue as we target the ASC setting.

Are you planning services program is also progressing well. This program allows facilities to offer fully personalized knee system as the deluxe upgrade option for their patients.

Since its launch on January six interest has been strong from ASC and hospital.

Schools.

We're educating all stakeholders about the numerous benefits of the program.

Central to generate additional facility revenue.

We developed and grit and launched our platinum services program to address the AUC opportunity, while simultaneously, providing a premium choice to patients as they consult with surgeons regarding their knee replacement options.

We believe that a leading indicator of our success is our ability to gauge the appeal to a broad spectrum of facilities, we're committed to providing additional metrics to help you monitor our progress of our new program through 2022.

Today, we have enrolled 18 health care facilities in the platinum services program and the pipeline remains robust, including many competitive accounts.

The growth of contracted platinum services facilities to be lumpy since contracting with new customers.

Variable experience, depending on the size of the customer and the number of stakeholders in the decision making progress.

That being said our team is energized with the new business opportunities that platinum services is creating.

<unk> and competitive accounts and we expect to grow the number of enrolled health care facilities, we do business with over the coming quarters.

Another favorable achievements are reported in the past quarter is the way we are extending our brand presence through strategic partnership with Synchrony financial a leading consumer Finance company Synchrony has added our platinum services program to their successful care credit offering which is accepted at more than 250000 provider in health care focused retail.

Location and has more than 11 million cardholders accounts.

We believe this will provide health care facilities and patients and easy to use and readily available financing option to offer patients for out of pocket costs related to the personalization service upgrades.

We've already noted that the platinum upgrade is eligible for any health savings and flexible spending accounts and now with care credit, we're making sure patients had increased access and choice and their health care journey.

Turning to the macro environment.

The procedures are still below pre pandemic levels and staffing shortages continue to persist across the health care system.

On the positive side Army ground seems to have run its course after peaking in January as we look to the future you're not expecting an immediate snapback in procedure levels, but we also do not anticipate any further major COVID-19 related shutdowns will we do expect as a methodical procedure ramp as clinic business to pick up in hospitals and agencies normalize operations.

And staffing levels.

Covid related issues combined with our business model transition has put our product gross margins under pressure over the past few quarters with a point of impact in Q1.

Drive through this as we are operating our manufacturing plant at suboptimal levels due to the challenges caused by higher than normal turnover in absenteeism.

Constantly changing staffing and shift rotations have negatively impacted our manufacturing efficiency and has triggered a higher levels of scrap that longer manufacturing times.

Certainly we've made strides in improving staffing levels and I'm pleased to report that we're currently at about 90% of our target levels.

It is important for me to point out that we believe these challenges peaked in Q1 and our gross margin will show sequential improvement throughout the year forecast that we will be back at our gross margin levels of low forty's by year end.

I am confident in our ability to do this especially given that this is a significant area of focus for the newest member of our executive team, Mike Phillips, who started with US in April 1st as our CFO . This is a new position for us, but one we plan to add for a while I'm extremely excited we were able to attract someone as talented and seasoned as Mike to our company. He has 30 years of experience in mass.

Any factoring operations and is well versed in applying lean principles to make plants run more efficiently.

Now I'd like to give you an update on important products and development our pipeline projects remain on track as follows.

<unk> primary hip stem continues to be on schedule for mid 'twenty two limited market release, <unk> will be a shortened approximately filling type design conducive to the popular direct anterior approach, we believe having a broader hip portfolio will help us to continue to grow our hip franchise.

We also remain on track for a fourth quarter limited market release of our poorest coated knee offering.

SUNS amended option will be the first available with our <unk> system and then we evaluate expanding the technology to a fully personalized platform.

Let me now turn the call over to Bob for more detailed financial review of the quarter.

Thank you Mark and good morning, everyone.

I'll start with a walkthrough of our financial highlights and then closed a few thoughts on our outlook.

Product revenue is our most important financial metric and we got a nice start to the year, we generated $14 9 million of product revenue, which was eight 6% growth over our first quarter last year.

This was better than our expectations, primarily due to fewer Q1 scheduled surgeries pushing out to future quarters.

The growth over prior year was due to a modest increase in elective surgeries and growth in our ASC channel.

Within product revenue sales of our conformance hip system were approximately 800000 up 18% compared to last year's first quarter.

Our hip growth rates are expected to accelerate later in the second half of the year as we expand our product portfolio with the limited Margaret lease of our Terra hip stem and Trialing by surgeons resumed in earnest.

I would now like now like to spend time on our product gross margin.

As good as we felt about our product revenue results, we had a similar level of disappointment in our product gross margin for the first quarter, which was 34, 1%.

Although we indicated on our last call that this metric will be under pressure and should be in the high thirty's during the quarter. Our plant continued to operate efficiently we experienced higher manufacturing scrap and we continue to face macro headwinds, including inflationary pressure higher input costs and supply chain constraints and labor shortages.

Additionally, our cancel case inventory expense was higher than forecasted this remained elevated during the quarter.

Unscheduled surgeries can still occur and we continue to work with health care facilities to establish procedural dates for these cases.

We are focused on improving these issues impacting our product gross margin, although we expect the macro headwinds will remain an overhang.

As Mark mentioned, we are now running about 90% of capacity from a workforce perspective, so we have bridged the gap on personnel.

Now we are working hard to get our workforce operating as a cohesive unit baidu.

By doing so we will improve labor efficiencies lower scrap improved delivery performance and accelerate our inventory builds to support our important full commercial launch.

I am excited Mike feeling and has joined the performance team and I'm looking forward to working with him to get these metrics back in line over the next few quarters.

For now our forecast show product gross margins sequentially, improving in Q2 to the mid to upper Thirty's and low forties in the second half of the year.

So this is a short term issue that we believe will for correct quickly.

Longer term, we believe that as we ramp in print in the platinum service program, we have a meaningful opportunity to further expand our gross margins.

I will now move to Opex.

Our total operating expenses for the first quarter were $20 5 million. This was about $5 2 million higher than the same period last year and related to a few items.

We had $1 6 million of higher costs in sales and marketing, which was partly due to the timing of the AOS trade show, which occurred in the third quarter last year. Additionally.

Additionally, we had higher commission and employee related expenses as we continue to invest in our commercial team to support our growth strategy.

R&D expense increased by 900000, primarily related to employee and project related costs required to support our product pipeline.

And lastly, we had $2 7 million of higher G&A expense driven by professional fees related to IP litigation and higher delivery expense as we again relied heavily on expedited shipping methods because of our manufacturing capacity challenges.

Our opex expectations for the year remain unchanged, despite Q1 being a little higher than expected.

Accordingly, we continue to expect operating expenses to be between 75 and $81 million for the year.

The timing and the buckets may change slightly as we manage to this number.

Moving to our balance sheet. It remains strong with cash and cash equivalents of $82 7 million at the end of the first quarter.

As highlighted last quarter.

Building, our inventory balance on in print knees, we expect this build to continue.

And we also add to the initial inventory production for the Caribbean over the coming quarters to support our product launch cadence.

Net cash flow in the first quarter was $17 8 million used which was higher than in recent quarters.

The increase was driven by low margins higher operating expenses timing of one time annual payments and changes in working capital.

We anticipate quarterly net cash used to improve throughout the year as revenue growth rates improve and product margins improve as well.

I will close with our outlook for the second quarter.

We expect our second quarter product revenue to be between 14, five to $15 5 million.

We confirm our full year product revenue expectations of $60 million to $70 million.

Couple of things to note on this range.

Sequentially from Q1 2022 it.

It is important to keep in mind that in five of the past six years, our second quarter product revenue has been lower than the first quarter due to a general seasonality trends.

I want to remind you that last year's second quarter had significant rescheduled activity from Q1 delayed surgeries during a period of heightened procedure recovery.

While our entire business was impacted by this in Q2 last year, our hip business had an even more pronounced level of rescheduled case activity that resulted in a relatively high Q2, making for a different difficult comp from a year over year perspective.

So taking all this into consideration like we did last quarter, we've taken a conservative approach to our outlook.

Our Q2 guidance does not assume significant improvement needed elective procedures, our staffing shortages and medical facilities, which.

We do not expect noticeable recovery in electric procedures until the second half of 2022.

With that Mark and I are happy to take your questions.

If you would like to ask a question. Please press Star then one if your question has been answered for me like to remove yourself from the queue press the pound key.

Our first question comes from Steven Lichtman with Oppenheimer <unk> Company. Your line is open.

Thank you.

Morning, guys I guess first I was wondering if you could talk a little bit about the intra quarter dynamics than what you saw I mean, obviously, assuming that January was the toughest but from what you saw exiting the quarter and any commentary you can make in terms of how that.

That trend, perhaps may have continued into April .

You're talking specifically just sort of macro demand sort of electric procedures that type of thing or that's correct. Yes.

Yeah. So.

Currently.

<unk>.

The question is omicron.

Faded away.

We saw less impact demand facilities, you know our healthcare customer facility customers.

And we saw some increased demand.

Pick up through the quarter.

You know April April sort of.

I think I pointed out in my comments Q2s is going a bit down so April sort of leveled off.

And.

You know that's why I think what we're saying I'm not saying that because if anything COVID-19 related I, just think procedure procedures sort of are going to have a slow rise, but you know for us.

We saw slight improvement.

But as far as the market, but we're still in that transition phase and that's why.

We've sort of given a range for Q2 that we've given as far as how April was.

Okay got it.

In terms of.

In print it sounds like feedback continues to be good.

What are the sort of the last pieces in your mind to get you guys ready for the full launch is there any additional feedback required or is it really just building out the inventory.

What are these final steps as you move toward.

The full launch.

Yeah, it's really so the team has done with where she has done a really good job on getting imprint on contract as you know in Med Tech. These these days you know access is a big thing.

We're very happy with the clinical performance. So theres nothing we have to do there.

It's really all operationally getting ready, but theres a couple components to that as you mentioned inventories the biggest one and that has been a challenge for us given what we dealt with having to year end last year and then obviously as we just did in Q1.

We're getting there, we're making the right strides, but we're not quite ready and when we say ready part of our commitment is we want to be able to.

Deliver imprint in a three to four week timeframe significantly faster than the six week time frame that we do with our custom five six weeks with customers depending on the product.

So that requires two things that requires having inventories I just talked about it also requires having our enterprise management system, our software all the commercial interactions.

Really really robust and sort out so theres some things you've had to do through warehouse software management systems and stuff like that that we haven't had to deal with frankly in the past where build the order.

So.

Those are just some processes that we're making sure our robust and reproducible. So that we can you know.

As I said slow flow orders through and deliver reliably in a three to four week timeframe unimpressed. So we're on track for June I will tell you. We were internally, hoping we would be able to be ahead of us heading into 'twenty, two but a lot of the macro events conspired to to make that more of a challenge.

But we've always said outwardly that it would be a <unk> launch and as.

As we sit today.

We still feel comfortable that we'll be able to do that.

Okay got it and then lastly for me Bob in terms of the gross margin you were.

You laid out the specifics on 22, which was which is really helpful. As we think about over the next couple of years. So can you remind us what are some of the.

Drivers to gross margin expansion in your mind.

Yeah.

As we look beyond this year and as you start working with life.

Yes, I mean, the biggies are obviously in print and platinum services will have a big contribution there as we grow that to be a larger portion.

Huge benefit for us so I would say that's probably the single largest element from a product standpoint, but then I would also say obviously.

Volume in general is going to help US right, we can leverage to the fixed overhead that we have in place.

That in combination with those two items planning services and in printing will be probably the biggest driver. So clearly we're ramping now.

But.

Certainly in 'twenty three.

We'd expect to see even more significant improvements as that becomes a bigger.

Yes.

Got it thank you guys.

Thanks, Steve.

Our next question comes from Josh Jennings with Cowen Your line is open.

Sure.

Hi, good morning, gentlemen, thanks for taking my questions.

And.

To.

Download this morning, I wanted to just ask on the <unk>.

And print launch in gist.

Follow up on Steves question on moving into a full launch mode.

How is how is your surgeon customer base.

Reacting to kind of a mandate to move away from customers outside of platinum service and kind of move fully to Cheetah print has there been any pushback. It seems like the transition is going very smoothly, but just wanted to check in on that element of the program prelaunch.

Well no. Just this is mark it's a great question and it's an important consideration any time you do it.

Change to your business model.

You know it can be upsetting to customers and it's a challenge to change our culture around from that standpoint.

I would say that.

All of it so we're talking about conformance current customers right people that work with them as.

Well those people all CV opportunity almost to an individual.

And I understand the pressures in the market and we think it makes.

Keen strategic shifts should do it.

Having until they understand having said that.

Theres, probably a few.

Less than 10%.

That is.

They want they've just they've just voice that theyre going to miss being able to give.

A true fully custom implant.

At no charge to their patients and now they have to move to our new model, which as you can get in print, which is sort of like call. It 75% of what we have with identity.

If they want to go the rest of the way then it's a it's a.

Patient pay upcharge or cash that's right. So you know those guys are.

Not thrilled but.

The flip side as they still want to work with us right they still understand it.

Many other people are fine and they supported us in getting access to the hospital.

I'd say frankly, some of them, we haven't turn them on because we are in limited release. So some of them haven't had access because isn't that turned on and so they're chomping at the bit to get it so to speak and we want to get it and what.

What we found is when they start using it.

They're actually really happy actually really happy because you know our bottling suggests that frankly in only 25% of the patients should even really see the sizing and the sheep disc difference because of the way we've designed imprint.

So thats bearing out as we as you know.

Turn customers over to that see in print.

And then the and then Theres the group like a third or so really excited about platinum services. They see the opportunity to offer a premium product, we see the opportunity to increase their service offerings to their customers and they're really really onboard with us because they because they're looking for something to happen.

A change in this industry tend to race to the bottom.

They want to have an outlet where they can give their Medicare patients choice. They can give their commercial patient choice and it's not always just about a race to the bottom on price. So.

This to me is exciting from that standpoint and that.

That's going to be the key discussion we have over the next few quarters is what kind of uptick we get with platinum services. Now. This is a long winded response, but I want to I want to extend it out to other things. This is really to your question about our own customers right because it's a change for them, but remember we're only a couple of points of market share.

Vast majority of customers are not performance customers and they really like in print you know, we're about I'd say about a third of our limited market.

Volume is competitive.

And we think we're gonna be able to do that well when we go to full market release and for them.

All upside to getting automatically sized implant they get.

They need a box at a price they want it's great for their ASC, we're seeing really good uptake.

See in limited market release.

You know I'll take I'll take that positive story every day the ability to have new discussions, which was always the point, we talked about Josh.

And we'll manage sort of the.

Well sure it would be.

<unk>.

The attitudes of our existing <unk> customers, because I really like the way the new customers are responding.

Understood that's helpful to think through and just on <unk>.

Pricing strategy for in print I mean, our understanding is it can be relative parity to other off the shelf implants from competitors, but just wanted to check in there on any changes to the pricing strategy has been moving into the full launch of imprint.

No.

No change I mean, we.

We are going we think we've got a better implant right and we also have a great cost savings story with our implant in box.

So that's great for us so we're just now able to be more flexible.

The meat price value opportunities that frankly, we just couldn't meet Josh with.

With our fully custom implant because the simple fact is when you make a standard.

Implant pull.

Off the shelf and has only a standard number of sizes.

You have lower cost of goods.

Because everything standard and it's all inventory, you're not throwing anything away all that other stuff. So so that gives us good pricing flexibility and that's what's going to get US both of these products whether.

Whether the customer buys from us, it's going to be margin accretive or if we end up doing the services due to that scenario the way the funds flow that's margin accretive to us. So this is a smart play for us.

But it's also a smart play for the market and our ability to address the markets now we're offering something.

That has value to.

As I said to these customers that are high value customers, who can never play that want lower price and now they want to get into the ASC. So that's number one and then number two now the opportunity to actually have revenue generating opportunity, which never existed before and getting into.

A deluxe service business is a great discussion that we're having with people. So we reported out 18 facilities. So take that for it was it was it was zero forever. It's disruptive nobody is doing it is early days, we expect that number to grow and we'll talk more about that over the coming quarters.

And just a quick follow up on this.

Does <unk> kind of crazy.

Great to see Youre seeing early early interest and demand.

In fiscal <unk>, but mostly.

Historic conformance customers or the mix of new and old.

Great.

And then lastly, just so any update on the Stryker agreement for PSA.

Okay.

That partnership.

Appreciate you taking all the questions right.

No. Thanks for asking John strike or still you know so that'd be agreement still remain good partnership good dialogue.

You know as we said we can't really comment on.

Where it's at I think.

It's still not as far as I understand fully and completely.

Or maybe that's been somewhere maybe it's like.

It's fully available, but I still think they still have a lot of training to do and they're still uptake. So.

I can't speak to that.

But from what I can tell the product works.

Is there it's just like anything else, we're trying to get incremental dollars in this inflationary environment and trying to deal with.

Trying to deal with the cost pressures that hospitals have.

That's a tough tough road. So you know it is what it is but.

Look it's.

It's all good we are delivering and they're able to order in.

We feel good about the partnership.

Yeah.

Thanks, a lot mark.

Thanks, Josh.

This concludes the question and answer session I will turn the call back over to Mark the destiny for any closing remarks.

Thank you operator, well once again everybody. Thanks for joining US here this morning, maybe.

It typically doesn't call in the morning, we'll evaluate if we want to continue with that going forward. It will move back to the afternoons a lot of it'll be based on what our analysts tough.

It works for them, but.

But thanks to the team for helping put this together we've got our annual meeting here later this afternoon and we thank everybody for their interest in.

Our investment performance.

We really do have a unique and compelling strategy that is bringing choice back to patients. We understand what we're doing is difficult and its disruptive because it's never been done before in orthopedics, but if you actually take the time to look around and it's been done a lot of other subspecialties and so we're excited to bring this forward to orthopedics.

So we look forward to giving an update on how it is progressing at our next call in August . So thank you everybody and have a great rest of your day take care.

This concludes the program you may now disconnect.

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